Investing? Try MIPs, FMPs for safety

January 22, 2007 10:49 IST

Few would dispute the fact that conditions in debt markets haven't been conducive from a long-term (over 12 months) investment perspective over the last few years. In fact, it's been quite a comedown from 2002, when long-term debt funds were the investors' darlings, thanks largely to a softer interest rate regime. Since then interest rates have witnessed a cycle and at present they are on the rise

In the recent past, the Reserve Bank of India has consistently raised its key lending and borrowing rates. And the uncertainty regarding how high interest rates will go isn't making the investor's cause any easier. Contrary to popular belief, we expect interest rates to rise even further. Hence, at Personalfn, we prefer to take a cautious view on the debt markets at this point.

Some of the factors which could ensure that interest rates rise going forward are - the growing inflationary pressures (fuel prices were cut recently but sooner or later populism will have to give way to realism and the crude price rise will have to be passed through to the consumer); and increasing demand for credit.

In light of the same, we present some debt fund categories which investors should consider for the purpose of investment in 2007.

1. Fixed maturity plans

FMPs are perhaps the most innovative products to have hit the debt funds segment in recent times. FMPs are close-ended products (investing predominantly in debt instruments), wherein the yield is locked-in at the time of investment. Hence investors know with a reasonable degree of certainty the return that their investment will generate and the tenure of investment as well. In effect, FMPs are also structured to offer capital protection (although implicitly), to investors.

Another variant from the FMPs segment is the one wherein a smaller portion (usually upto 20%) is invested in equity assets. Such FMPs offer the twin advantage of capital protection (taken care of by the debt portfolio) and capital appreciation (provided by the equity portfolio).

FMPs hold an edge over other avenues like fixed deposits in terms of tax-efficiency. Hence for investors in the higher tax brackets, who wish to invest in the debt funds segment, FMPs could make an apt fit. Investors would do well to appreciate that FMPs are structured to offer capital protection and appreciation; however, there is no explicit guarantee on either front. To that end, FMPs are different from FDs and would rank higher in terms of a risk-return trade off as well.

2. Monthly income plans

As the name suggests, MIPs intend to offer income on a regular i.e. monthly basis to investors. However the monthly income is not assured, the same depends on the fund's

performance, which in turn is a factor of the markets. Generally, MIPs invest around 75-80 per cent of their corpus in debt instruments and the balance (20-25 per cent) is held in equities.

Often the equity component is the defining factor for MIPs. While low-risk MIPs would typically hold between 10-15 per cent of their assets in equities, the high risk ones can hold as high as 30 per cent of their assets in equities. Like most hybrid instruments, MIPs offer the proposition of diversification across asset classes. The debt component is intended to offer stability to the portfolio, while the equity component is utilised to offer the much-needed impetus i.e. capital appreciation.

3. Liquid and short-term floaters

Given our view on interest rates, we recommend that investors avoid investing in long-term debt funds just yet. When yields rise, investors can benefit only if they are invested in short tenured debt instruments, especially the floating rate ones. Floating rate instruments have their coupon rates reset in line with that of a benchmark rate (like MIBOR) at fixed time intervals. Hence in a rising interest rate scenario, the instrument is equipped to deliver higher returns.

Liquid funds (which typically have very low maturity profiles) can prove to be the apt avenue for investors who wish to park their funds for shorter time frames. Investors who have an investment horizon of a couple of weeks should go in for "Liquid Plus" funds, which offer a relatively better yield, without taking on much additional risk.

4. Short-term fixed deposits

While FDs wouldn't necessarily fit into the definition of a conventional debt instrument, they could certainly merit inclusion in the risk-averse investor's portfolio. In view of the fact that we expect interest rates to rise, we recommend that investors should not lock their money in long-term FDs. They should instead opt for short-term FDs. This will ensure that they can invest in fresh issues with higher interest rates.

In conclusion, we would like to remind investors of the importance of having access to an expert and qualified investment advisor. An investment advisor has a vital role to play in ensuring that you achieve your financial goals. He is the one who will help you select the right instruments from across categories and construct a portfolio that is aligned with your risk profile. Once investors have access to the right advisor, it would be fair to assume that the right instruments will follow.

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